As the US nears the “fiscal cliff,” the idea of a revenue-neutral carbon “tax swap,” which would see revenue from a carbon tax used to reduce other taxes, while driving innovation in energy efficiency and alternative energy, has been proposed by a number of policymakers and academics.

A new report from the Institute for Energy Research argues against the carbon “tax swap,” pointing to technical and pragmatic flaws, such as the probability of emissions “leaking” to other, less regulated regions, like China. A report from MIT, however, found that a carbon tax would have multiple benefits, such as reducing emissions, achieving new revenue, and driving private spending. The Brookings Institute also released a paper calling for a carbon tax, saying “Congress and the president should implement a $20 per ton, steadily increasing carbon excise fee that would discourage carbon dioxide emissions while shifting taxation onto pollution, financing energy efficiency (EE) and clean technology development, and providing opportunities to cut taxes or reduce the deficit.”

Is a carbon tax sensible energy policy? What are the consequences of such a tax?

Is a carbon tax sensible energy policy? What are the consequences of such a tax?

5 Responses to Carbon Tax on the Table

The recent conference at AEI — jointly sponsored by Brookings, RFF, and the IMF — spent 8 hours, with 4 panels, to discussing many aspects of The Economics of Carbon Taxes. Video of all sessions is available here: http://j.mp/PVLLu4

I thought the presentation by Karen Palmer of Resources for the Future provided a particularly useful review of the many difficulties involved in contriving an efficient and effective carbon tax. Among those is the many complex ways a federal carbon tax would overlap and/or interfere with a variety of tax, regulatory, and other policies — state and local as well as federal. The number of different purposes proposed for a carbon tax — raising revenue to reduce deficits, reducing carbon emissions, funding infrastructure, reducing congestion and/or air pollution, etc. — also can be inconsistent and contradictory.

Whatever else was to be learned, the conference conveyed that while a carbon tax may seem highly efficient in economic theory, in practice it is immensely complicated.

Moreover, it seems unlikely that a carbon tax would be considered by Congress independently from the movement for more comprehensive tax and budgetary reform. This will compound the complexities of the carbon tax question with the vastly greater complexities of the general federal tax code.

Still, given the urgency of the federal fiscal crisis, it is possible that some sort of carbon tax might be included in the final plan to avoid the ‘fiscal cliff’. It is unlikely that the tax would be large enough to have any significant effect on fuel consumption, carbon emissions, and hence climate. The $20/ton figure often mentioned translates to about $.20/gallon of motor fuel. Moreover, because the carbon tax is intrinsically regressive, there will be pressure to refund much of the proceeds to middle/low-income taxpayers — which assures that they will be respent on consumption.

Despite repeated proposals, it has been politically toxic to raise the inflation-diminished federal gas tax of $.184/gallon just to meet the intended purpose of paying for progressively crumbling, congested highways, bridges, tunnels, etc. It seems very unlikely that raising the carbon tax to a level that would significantly alter consumption behavior — several dollars/gallon — would have any chance of being politically enacted. And that is even if the revenues were used to offset cuts in income or other taxes in a more ‘neutral’ type of reform.

At best, it may be possible to impose a modest carbon or fuel tax to help fund the R&D and innovation needed to “make clean energy cheap.” That would be predicated on the promise that fossil fuel consumption could be reduced if and when there are technical alternatives available to consumers that offer comparable/better utility at competitive market prices (without subsidies). That would be consistent with the strategy proposed by Brookings, Breakthrough Institute, AEI, ITIF, and here: http://j.mp/WXLVS9.

If a person looks at the actual world CO2 emissions history, one sees that world emissions took a sharp turn for the worse immediately after the Kyoto Protocol was signed.
[img]http://gailtheactuary.files.wordpress.com/2012/09/world-carbon-dioxide-emissions.png[/img]

The Kyoto Protocol gave two signals to the developing world: (1) that the signers would be smaller users of coal in the future, leaving more coal for the non-signers, and acting to hold down prices of coal traded on the international market, and (2) that signers would tend to charge carbon taxes on goods made within their own borders, while permitting import of goods made in Asia, without carbon taxes on imported goods. This approach would help to make Asian goods more competitive. The combination of cheap labor and cheap coal for energy already had the makings of a winning competitive edge for Asian countries; adding a possible carbon tax made international trade even more advantageous for Asia.

Not surprisingly, China joined the World Trade Organization not long afterward, in 2001, and its energy use (primarily coal use) shot up:

Probably not by coincidence, the US for the first time in 50 years started seeing a long-term drop in the number of its citizens employed, about the time China joined the World Trade Organization. (The United States, of course, was not a signer of the Kyoto Protocol, and did not itself enact a carbon tax). A major reason for this decline in proportion of US citizens employed would seem to be the transfer of jobs to China and other Asian countries. I talk about the close connection between the number of US jobs and historical energy consumption in this post.

While I have not looked at the details of the current carbon tax proposal, it seems to me that we should be very cautious about using an approach which seems to have worked extremely badly in the past. If our primary goal is to reduce world carbon emissions, and our secondary goal is to increase United States employment, we should be finding ways to move manufacturing into the United Sates, and out of Asia. I am not sure what it would take for this to happen, but I am doubtful that a carbon tax would be part of the package.

Both of the commentators above present issues that make a viable carbon tax at best difficult, at worst economically damaging. However, neither set of issues make a carbon tax less desirable economically, they just underline the complexity of its enactment.

As for design, while almost any positive tax will raise revenue for the federal government, the tax itself should be based on the principal of pricing high-carbon fuels out of and low-carbon fuels into our domestic fuel mix. For example, aiding the economic viability of renewable resources via a carbon tax would be far more helpful to further development – and easier on the national budget – than bribing developers with tax credits. Enacting a straight-ahead carbon tax now, then dealing with the issue of its regressive nature during an overall tax code overhaul might be a suitable two step process with which we move ahead.

As for the issue of domestic vs. global emissions, two thoughts come to mind. The first is that our government has a primary duty to attend to domestic issues. Further, it has only limited ability to impact emissions in other countries. I do agree that putting ourselves at a disadvantage via the added business burden of a carbon tax while others burn cheap coal and increase atmospheric CO2 is self-defeating. But we have reduced our own emissions economically via the domestic natural gas surplus displacing the burning of coal for electricity generation. As long as we don’t export the surplus, that process should continue for years. Perhaps the best path to follow is to teach the Chinese how to frac their extensive shale gas deposits. They have a genuine air pollution problem they’d like to solve. If that works, maybe the next thing for them would be a Chinese carbon tax.

I agree with other comments that the conundrum is how US policy would affect carbon emissions globally. Projections from the World Resources Institute on the sheer number and capacity of planned new coal plants globally is staggering – over 1000 new coal plants and 1400 GW (full report available at http://pdf.wri.org/global_coal_risk_assessment.pdf). Estimates for global temperature reduction even if the US implements a carbon tax (and rest of the world does nothing) is zero. Thus, a domestic carbon policy will have little impact without addressing ways to reduce carbon emissions from fossil sources (including natural gas). Any carbon policy would have to support R&D investment in carbon sequestering and use technologies. IEA analysis (World Energy Outlook 2012) suggests that carbon capture and storage (CCS) technologies must be part of the global solution for the power sector. While CCS still seems too far off from full scale to make a difference, the expanding global reliance on coal necessitates the need for emissions mitigating technologies. US carbon policy should be focused on this objective.

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